Debt ceiling and possible default – 4 scenarios for the US economy

The deadline to establish a limit on US debt is fast approaching on June 1st, but Congress has yet to resolve the issue and both Republicans and Democrats seem to be at a deadlock, wrote Business Insider. The absence of a single party in control of Congress is a significant worry for the economy of the US and possibly even the rest of the world. Market participants usually expect any impasse surrounding the debt ceiling to be resolved promptly to avert default, which would undoubtedly harm the global financial system and cause a recession in the US.

Ned David Research has created four potential scenarios outlining their impact on the US economy. The most undesirable scenario is the continuation of confrontation after the deadline has passed, with a 5% chance. In this scenario, the government will be partially unable to pay off its debt and skip payments to pensioners, veterans, military personnel, and contractors but will continue to make payments on government bonds. Due to a partial default, credit agencies will lower US debt ratings, leading to an increase in risk premium. There will also be a decrease in consumer confidence and spending, and the US economy will enter a recession.

The second scenario involves raising the net debt ceiling, with a 10% probability. The US will be able to avoid default entirely if Republicans withdraw their spending cut demands at the eleventh hour. In this case, the forecast for US GDP growth in 2023 would remain unchanged.

The third scenario involves the Biden administration conceding to some of the Republican demands, with a 20% chance. In this case, default will also be avoided, and reductions in government spending will commence in this year and the following year partially. The negative aspect will be investor and business uncertainty because expenditures approved by one Congress can be nullified by the next one. This scenario will result in slowing down economic growth in 2023 and 2024.

Finally, there is the fourth scenario, in which the debt ceiling is suspended, with a 65% chance. In this case, Congress will pause the debt ceiling to continue negotiations, preventing default and potentially reducing some government spending. If Congress postpones the problem for several months, the same issues will reappear later, leading to a slowdown in economic growth in 2023 and 2024.